One conversation could save you millions…
The normal tug of war that happens when trying to figure out whether you should do an asset sale vs a stock sale while you’re buying or selling a business doesn’t have to be as black and white as you think. There is a small tool that could save you millions of dollars, but that so many people simply don’t know about. This unsung hero goes by the name of ‘the 338(h)10 election.’
Buried away in the bylaws of our tax system, the 338(h)10 basically enables a stock sale to be treated as an asset sale for tax purposes. But what does this actually mean?
Stock or asset?
Bear with us if you already know this but before we elaborate on the 338(h)10, we need to establish the difference between a stock sale and an asset sale. This is often one of the biggest hurdles in a business sale, with the buyer normally preferring an asset sale while the seller commonly holds out for a stock sale.
Taxing
It all boils down to tax. For the buyer, an asset sale is preferable because the assets can immediately be depreciated for tax purposes. This is referred to as a “stepped-up” tax basis. This is great for the buyer but a nightmare for the seller because all of the money raised from the purchase becomes ordinary income, which could put the seller in 50%+ tax territory. A stock sale on the other hand will be capital gains tax which would land somewhere in the 20-30% range depending on your state.
Liabilities
The other main factor in the asset sale vs. stock sale debate is the concept of liability. In simple terms a stock sale means that the buyer takes on more liability. Let’s suppose that after the sale there is a lawsuit filed against the company relating to negligence that occurred before the sale. In this scenario the new owners would still be liable. Any seller would surely like the idea of a clean break, but any buyer would be mindful of what skeletons may lie in the closet.
The best of both worlds
But the main issue is the tax. If only it were possible for both the buyer and the seller to do a deal that is tax efficient for both parties, where one does the stock sale and the other does the asset purchase. Oh wait a minute… it is possible! Remember our friend the 338(h)10 election? Using that as part of the deal will enable the seller to relinquish the business fully as per a stock sale, but will also enable the buyer to effectively take on the business as if it were tax-deductible assets. Sure, there are issues of liability for the buyer that wouldn’t have been there if it were a straight asset sale, but that’s a small price to pay compared to if the seller had held out for a conventional stock sale.
You scratch my back…
The mutual benefits don’t have to end there. The very concept of a tax windfall is great leverage in any deal, leaving open the possibility of both sides meeting in the middle and splitting the benefits evenly.
Straight from the horse’s mouth
Here is a word from a private equity group and how they view the strategy…
“Generally, Sellers don’t like a 338h10 election because it increases their tax burden as compared to a straight stock sale, but the benefit to us as the Buyer is generally high enough where we would gross up the seller and likely even provide additional savings. Typically, the way it works if an advisor is doing a good job is when Buyer requests a 338 h10, their advisor will negotiate the splitting of the tax savings with Buyer which is a good middle ground.”
Is this possible for all business sales?
If both companies are corporations then yes – definitely. For a lot more detail on exactly who does and doesn’t qualify for 338(h)10s, see this article.
Collaboration
Beyond just simply knowing how the law can save you tax, the key takeaway from this is that proper collaboration with the ‘other’ side can create a scenario where both sides win. If it looks on the face of it that a 338(h)10 election is going to favor the buyer a lot more than it favors the seller, then the seller has a nice bargaining chip to gross up the sale price with. Why would the buyer say no if they are still able to save a massive amount in tax overall? By approaching negotiations from the outset by thinking “how can we BOTH do well out of this deal?” rather than “how much can I get from the deal?”, you’d be amazed at what might be possible.